Mohender Anand v. Her Majesty the Queen, [1994] 1 CTC 2785, 94 DTC 1565

Sobier, J.T.C.C.:— The appellant originally appealed the assessments made by the Minister of National Revenue (the "Minister") for his 1988 and 1989 taxation years.

On consent, the appeals with respect to the unreported income in the 1988 and 1989 taxation years are dismissed. The Minister, through counsel for the respondent, agreed at the hearing of the appeals to drop the penalties related to the unreported income of $2,000 and $6,300 in those years.

The only remaining issue is whether the appellant’s share of the gain on the sale of 8 University Avenue, Guelph, Ontario was on account of capital or income. The Minister assessed the appellant on the basis that the gain was on account of income and of course the appellant maintains that it was a capital gain.

The appellant is a real estate agent and has carried on business in the City of Guelph, Ontario since 1983. It was his evidence that one Lakhbar S. Lal noticed an advertisement in a local newspaper relating to the sale of a property known as 8 University Avenue. The property was close to the University of Guelph and was shown on an MLS listing document as being rented to six students.

Mr. Lal approached the appellant seeking his advice on purchasing the property as an investment. It appears that Mr. Lal alone eventually made an offer and the offer was finally accepted. The purchase price was $155,000 of which $116,000 was financed by a mortgage in favour of the Royal Bank of Canada and $30,000 by a mortgage in favour of the vendor.

Between the time of the signing of the agreement of purchase and sale on April 8, 1987 and the closing on July 28, 1987, the appellant agreed to become involved with Mr. Lal in the purchase and acquired a 50 per cent interest in the property.

The appellant gave evidence that he made calculations which indicated that the operation of a rooming house with six student tenants would be profitable. However, he later stated that this proved to be based on an incorrect assumption, which was that the students would occupy the rooms on a year round basis and not merely for the school year.

The vendor and the purchasers used the same solicitor. The solicitor was not instructed by the purchasers to verify that the applicable zoning by-laws of the City of Guelph permitted the operation of a rooming house at 8 University Avenue. In addition, neither the appellant nor Mr. Lal made any attempt to verify the zoning themselves. According to the appellant, no discussions concerning the zoning were carried on with the vendor. The purchasers received no reporting letter from the solicitor.

However, regarding the zoning, the agreement of purchase and sale contained the following paragraph:

6. Purchaser shall be allowed until 11:59 p.m. on the 30th day of June 1987 to: examine the title to the property, at his own expense, to satisfy himself that there are no outstanding work orders affecting the property, that its present use multi single [1] family dwelling may be lawfully continued, and that the principal building may be insured against risk of fire.

The offer was prepared by the appellant and strongly indicates that the appellant was aware that the property was not zoned for a student rooming house.

Pursuant to a letter of October 6, 1987 from Mr. Ted Brown, a zoning inspector with the City of Guelph, the appellant and Mr. Lal were advised that the occupancy did not conform with the zoning by-law but that there was a legal nonconforming occupancy for a family plus three roomers.

In a letter from the appellant's accountants to the city of Guelph dated November 18, 1981 it was stated that:

Further to our telephone conversation I have spoken with Mr. Anand regarding the questions you raised regarding the purchase and sale of 8 University Ave., in Guelph and received the following responses:

The third response reads as follows:

Mr. Anand had no special knowledge about this property other than that any property in the City of Guelph could have been rented under city by-laws, i.e., four unrelated people in one house, thus the property was rented to University of Guelph students as it appeared to be a valuable long-term rental property.

From this statement, it appears that Mr. Anand should have known at the time of the purchase of the property that a rooming house with six student tenants was not even in conformity with what he thought the zoning by-law was. Mr. Anand's statement to his accountant indicates that at that time of purchase, he knew of the problem which should have put him on notice that the question of illegal occupancy might arise. He chose to ignore it.

Concerning the rental stream, as stated above, the appellant gave evidence that he made a mistake in not realizing that students did not rent for 12 months. However, Mr. Anand also stated that he had rented 324 Gordon Street to students since at least 1985 having acquired the property in 1984. He also stated that the property at 332 Gordon Street, which was acquired in 1985 and owned equally with his wife, was also rented to students. Therefore, prior to 1987 he would have knowledge of student rental operations.

Mr. Anand stated that on October 10, 1987, i.e., within four days of the date of the zoning department letter, the property was listed for sale. This was done perhaps for two reasons. The first being that he could not continue to rent to six students, and secondly, to stave off prosecution for breaking the by-law. Such a short period of time before listing gave no opportunity for negotiating with the city. However, I find that prior to purchasing the property the appellant was well aware that there were problems concerning the use of the premises which, if discovered by the city, would create difficulties.

One must now examine the appellant's intention at the time of purchase. Did he purchase the property as an investment, i.e., on capital account or did he purchase with a view to resale, i.e., as an adventure in the nature of trade and therefore on income account? Also, even if the purchase was on capital account, was there a secondary intention to sell if the investment did not work out?

There was evidence that the appellant and his family were involved in other real estate transactions including the purchase and sale of rental properties, building and selling new homes through a corporation of which he was a 50 per cent owner. The appellant and his wife acquired property jointly. She acquired and sold property on her own account and Mr. Anand bought and sold property also on his own account and Mr. Anand's daughter acquired property from a corporation in which he was a shareholder.

In dealing with whether this transaction was on income or capital account, counsel for the respondent referred to Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421 (F.C.T.D.).

In that case, Rouleau, J. referred to the tests set forth in M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125 (Ex. Ct.). After setting forth the six factors in Taylor, Rouleau, J. stated at pages 263-64 (D.T.C. 6424):

While all of the above factors have been considered by the courts, it is the last one, the question of motive or intention which has been most developed. That, in addition to consideration of the taxpayer’s whole course of conduct while in possession of the asset, is what in the end generally influences the finding of the Court.

This test has been carried one step further by Canadian Courts into what has generally been referred to as the “secondary intention” test. This has meant, in some cases, that even where it could be established that a taxpayer’s main intention was investment, a gain on the sale of the asset would be held taxable as income if the court believed that, at the time of acquisition, the taxpayer had in mind the possibility of selling the asset if his investment project did not, for whatever reason, materialize. In Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.), Noël, J. provided the following summary of the secondary intention test at page 159 (D.T.C. 5103):

. . .the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention” if one wants to utilize this term.

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

The appellant made it clear that he was aware of the hot real estate market in Ontario in 1987. Being in the business, he knew that profits were being made. He knew or ought to have known of the zoning problems. He knew or ought to have known that as an investment capitalized as it was, there would not be sufficient income to support it.

The rapidity with which the property was listed is an indication of his secondary intention. Nothing was done to attempt to settle the dispute with the City of Guelph. The property was listed and attempts were made to sell it. The appellant was not attempting to extricate himself from a problem. He waited until he got his price. The price was raised even though no offers were made at the lower price. At the time of purchase he must have known that there was a profit to be made on resale in that market and indeed there was a profit made.

Also distressing was the fact that the appellant’s wife was put forth as the owner of the property, both for claiming rental losses and for claiming the capital gain on the sale of the property. The appellant claims that it was his accountant's error in reporting in this fashion. I cannot for one moment believe that the appellant would not have known that he, not his wife, should be reporting the rental losses and that he, not she, should be reporting the gain on the sale. He advised Mr. Lal. He set up the transaction. He prepared the offer to purchase. He was the one invited by Mr. Lal to participate. He was on title as a co-owner. He was on title as co-mortgagor. This treatment of the rental losses and the gain on the disposition does nothing to enhance the appellant's credibility.

There are many factors which must be taken into account. Even though there could have been an intention to hold as an investment, this evidence leads me to believe that the appellant would have been prepared to sell in the short term if the circumstances warranted.

Having considered all of the evidence, I have no difficulty in determining that at the time of the purchase of the property, the appellant knew or ought to have known of the difficulty in keeping the property as an income producing property and renting profitably and given the real estate market at the time, he knew he could sell the property at a profit if he could not operate the rooming house. He had a secondary intention of selling and therefore the gain on the sale was on account of income.

For these reasons, the appeals are dismissed with costs.

Appeals dismissed.